More times than I can remember, I have said that protection and preservation of capital is the fundamental rule of trading. Simply, if you blow all your cash, how can you trade? And as any successful trader will tell you, placing stops is one part of protecting and preserving your capital. Given this I am advising you all to read Jim Wyckoff’s e-book, The Art of Effective Stop Order Placement in Trading Markets (found right here on this site–Education, Resource Library, E-Books). His lucid explanation of the available stop orders is illuminating and helpful to any trader. As well, he discusses strategies for placing stops in a variety of situations. For example,

“On specifically where to place your protective buy or sell stop upon entering a trading position, one of the most popular and effective methods is to find a technical support or resistance level that is within your financial loss parameter for that particular trade.”

As well, he discusses one of the points I have also made time and again and that is:

“If your trade becomes a winner and profits begin to accrue, you may want to employ protective ‘trailing stops,’ whereby you adjust your protective stop to help you lock in the profit should the market turn against your position.”

Letting your profits run does not mean letting the trade run without protection. If you find your trade hitting your profit target, and the trade is still showing strength, either tighten your stop or place a trailing strop to track that run.

The e-book is helpful for the trader who wants to know more about stops and how to use them. The end of the book, however, touches on a topic that has long frustrated me in my trading, and if you have never thought about it or had it done to you, the e-book is worth reading for this alone. The topic is floor traders picking off stops for their benefit.  

“For decades the individual small trader has heard unsettling stories that the floor, or pit, traders know exactly where the stop orders are placed in a market, and will ‘gun’ for those stops just to eject the individual trader from the market–only to see prices then reverse course after the stops were triggered.”

Jim explains that conditions have to be just right for this to happen, and that it happens less today than it used to because of the communications changes that now send information down to the “pits” rather than up from the pits. This may be true, but let me tell you, it definitely still happens, and you need to know that it still happens. What to do about it, though, is another topic all together. I have yet to figure out how to avoid this, other than to slightly change your stop when the price nears your placement. And since I have stated over and over again never changing your stops is good money management, I am somewhat stuck, as you are if you follow my advice. Perhaps the solution is embedded in a key sentence in the e-book,

“Floor traders seeking out the individual traders’ protective buy and sell stops is more an art than science, as market conditions have to be just right for their efforts to pay off.”

Placing stops can also be more of art than a science. Placing stops that work at both ends of the trade will come down to how well you understand your market, the movement of that market, and the overall market conditions surrounding your trade.  

Trade in the day; invest in your life …

Trader Ed